MPC takes note of economic reality

MPC’s decision to hike rates is anything but drastic when seen against the prevailing external economic situation

That the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) would increase the policy rate was a given. It has done so by 25 basis points, in keeping with expectations. What was watched more keenly was MPC’s prognosis of the larger economic situation. On that front, it has not held back from underlining the inherent tension in the Indian economy: resilient domestic momentum against a multi-faceted turbulent external economic environment.

RBI’s mandate, given the situation, was to ensure that inflation does not become — and more importantly, is not seen as becoming — widespread. (HT Archive)

India’s growth forecast for the fiscal year has been revised upwards from 6.7% to 7.1%. The biannual Monetary Policy Review says that unless there is a major disruption, GDP growth will be 7% in 2027-28 . The inflation forecast has been moved up from 5% to 5.2%. Expected crude oil prices have also been revised upwards. RBI also believes that elevated bond yields and AI-driven equity asset valuations in advanced markets are not going away anytime soon.

RBI’s mandate, given the situation, was to ensure that inflation does not become — and more importantly, is not seen as becoming — widespread. India’s monetary policy cannot be seen as oblivious to what clearly looks like a tight-for-long monetary pivot in advanced economies.

The change in policy stance to calibrated tightening — the Governor has clearly said this means rate cuts are off the table in the near term and policy action ahead can only be a rate hike or a pause — is a good way to approach the problem. MPC has clearly conveyed its stance that it will not sit back and let inflation escalate but also decided against being seen as dogmatically pursuing inflation by raising rates. That the MPC resolution talks about how rate hikes tackle supply side constraints — the source of most of the current inflation — is yet another example of this approach.

All said, MPC’s latest decision is anything but drastic when seen in comparison to the prevailing external economic situation, especially in commodity and capital markets. This also raises an interesting question. India’s inflation story would have been much worse had the government decided to pass on the full cost of increased fuel or fertilizer prices to consumers. The pain has been offset by passing a large cost to the fiscal numbers. We will know more about this closer to the budget. A consolidation next year may also create headwinds for growth.